The lure of a guaranteed income stream for the remainder of one’s life leads many Americans to invest billions of dollars in annuities each year. In 2016, over $220 billion of annuities were sold. Who wouldn’t want stable and secure income during their retirement years? Most of us would, but the insurance companies that create these products attach a big price tag and the drawbacks of having your money locked up often leaves investors with buyer’s remorse.

What is an annuity?

An annuity is a contract between the policy holder and an insurance company. Depending on the type of annuity purchased, the owner can elect to receive guaranteed payments for life or to have payments made over a specified length of time.

Are there different types of annuities?

There are two basic types of annuities: deferred and immediate. With a deferred annuity, your money is invested for a period of time until you are ready to begin taking withdrawals, typically in retirement. For an immediate annuity, you begin receiving payments soon after you make your initial investment.

Fees

One of the biggest disadvantages of an annuity is the expensive fee that is often attached. Annuities are cash cows for insurance companies and the brokers that sell them. The commissions and annual expenses associated with annuities can be very high and very difficult to understand. Typically, the fee earned by the broker selling an annuity is around 5% to 6%, but it can be as high as 10%. In addition, there are annual expenses that can run between 2-3%. The lack of transparency in these products allows brokers to take advantage of investors who are worried about outliving their assets. This is a big reason why annuities have garnered such a bad reputation.

Liquidity

After buying an annuity, that money is locked in for a certain period of time, typically from six to eight years. You can technically take the money out, but you pay a surrender charge for access to your money. You may also pay penalties if you withdraw before age 59½, in addition to any applicable taxes. If an unexpected event occurs and you need a lump sum of your money, the cost of getting your money back can be quite high.

What should you do if you own an annuity?

We typically do not recommend annuities because of the aforementioned drawbacks, but if you already own an annuity, we can help. If the annuity has been held longer than seven years, it may be possible to find and transfer your money to a lower-cost annuity through what is known as a 1035 exchange. A 1035 tax-free exchange is the IRS tax code that allows for the rollover of a non-qualified annuity to a new annuity or life policy of equal or greater value. Capital gains and/or income taxes will not be realized from this type of transfer when completed properly. Please feel free to contact us if you have further questions.

Individual investment positions detailed in this post should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Employees and/or owners of Nelson Roberts Investment Advisors, LLC may have a position securities mentioned in this post. Please contact us for a complete list of portfolio holdings. For additional information please contact us at 650-322-4000.